Scoring benefits consumers, regulators and taxpayers: credit scores allow underwriters to accurately assess risks, allowing them to charge a fair premium

Risk & Insurance, Sept 15, 2004 by Kevin T. Sullivan

The use of credit-based insurance scoring is the most significant advancement hi cost-based pricing in the past 30 years. Insurance scores are derived from information contained in credit reports and are used to help insurance companies determine which risks to accept and how to allocate premium accurately among the risks that are accepted.

Insurance scoring is good for consumers, insurance agencies, insurers and the marketplace. It allows insurers to reward customers in -already existing risk pools with lower premiums and to write more consumers than they otherwise would. Insurance pricing and actuarial science is based upon the fundamental belief that premiums should be related to risk of loss. Using insurance scoring as part of cost-based pricing results in premiums that more accurately reflect risk of loss for each consumer, thereby reducing subsidies, which effectively are hidden taxes.

Insurance searing allows more opportunity for individuals to be charged relatively lower premiums based on behavior they can control. In addition, even those who are not initially charged lower premiums benefit because insurance is more available to them and because they may be less likely to be non-renewed. Information that is accurate, predictive and difficult to falsify is absolutely critical for appropriate underwriting and rating. The greater the accuracy and reliability of the available data, the more healthy the marketplace for insurance, which mean lower costs, greater availability and more stability for the consumer.

Information obtained from credit reports is information that helps insurers more accurately determine the cost of insurance, thus driving down prices and creating greater stability in the marketplace, which benefits everyone.

The relationship between credit history and insurance losses is not a matter of theory or conjecture, but of statistical reality and fact. State insurance regulators have recognized the strong correlation between credit-based insurance scores and future insured losses.

We have seen, and continue to see, an extremely strong correlation between information included in a person's credit report and the likelihood of insurance losses. For us, what matters is that certain information in credit history predicts losses and that its use allows us to provide more consumers with insurance at lower prices. In the face of irrefutable data based on actual loss experience, some critics at the state level continue to question the value of this knowledge. We find this surprising because the link between credit history and loss potential has been studied extensively by many scholars independent of the insurance industry, in fields such as psychology, safety engineering, occupational medicine, consumer research and risk perception.

Over 30 articles and studies that we have analyzed point to two possible explanations. One explanation relates to risk-taking behavior. Different people have different aversions to risk. Some people like to skydive. Some people are afraid of the amusement park roller coaster. Some people will run a yellow light if it was yellow when they first saw it. Some people will stay under 55 miles per hour on the highway.

People who are more likely to take risks are more likely to get into serious financial difficulties (bankruptcies, liens, foreclosures, etc.) than those who are more risk averse. As the studies show, people who are more likely to take risks are also more likely to get into auto accidents. Therefore, some people with poor scores are more likely to engage in risky behavior and thus more likely to incur losses.

KEVIN T. SULLIVAN is a wee president in the corporate relations department of the Allstate insurance Co. He delivered this statement to Congress in June 2003 in the context of reauthorization of the Fair Credit Reporting Act. The statement has been edited to fit the page.